An independent trader or trading firm that is prepared to buy and sell shares or contracts in a designated market. Market makers must make a two-sided market (bid and ask) in order to facilitate trading. A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid-offer spread, or turn.
Bid, Ask and Quotation
The highest price at which a floor broker, trader, or dealer is willing to buy a security or commodity for a specified time.
The lowest price at which market makers and floor traders of a specific market are willing to sell a security, and the price at which an investor can buy it from a broker-dealer.
Refers to the highest bid and lowest offer (ask) price currently available on a security or commodity. An investor who asks for a quotation or quote on AOL may be told “70 to 701/2.” This means that the best bid price is currently $70 per share and that the best ask a seller is willing to accept is $701/2 at that time.
Liquidity
The ease with which an asset can be converted to cash in the market place. A large number of buyers and sellers and a high volume of trading activity provide high liquidity. Market liquidity refers to the extent to which a market, such as a country’s stock market or a city’s real estate market, allows assets to be bought and sold at stable, transparent prices. Liquidity reflects whether there is a ready market for an asset—the ease of converting it to cash. Cash is the most liquid of assets; tangible items, among the less liquid.
Hedging
Reducing the risk of loss by taking a position through options that balances out or significantly reduces the risk of the current position held in the market. Hedging is a risk management strategy employed to offset losses in investments.
The reduction in risk typically results in a reduction in potential profits. Hedging strategies typically involve derivatives, such as options and futures. The best way to understand hedging is to think of it as a form of insurance. When people decide to hedge, they are insuring themselves against a negative event to their finances. This doesn’t prevent all negative events from happening, but something does happen and you’re properly hedged, the impact of the event is reduced. In practice, hedging occurs almost everywhere and we see it every day. For example, if you buy homeowner’s insurance, you are hedging yourself against fires, break-ins, or other unforeseen disasters.
Mutual funds
An investment company that pools investors’ money to invest in a variety of stocks, bonds, or other securities. Each mutual fund’s portfolio matches the objective stated in the firm’s prospectus; the type of portfolio guides the fund’s professional manager to pick appropriate securities for the fund to buy.
Mutual funds are divided into two categories: open-ended and closed-end funds. Both varieties have portfolios of stocks (and sometimes bonds) and cash that are professionally managed. The market value of the portfolio is called the net asset value” or NAV. The NAV is calculated by dividing the number of shares by the market value of the fund’s portfolio.
The closed-end fund has a fixed number of shares, whereas the open-ended fund continually issues new shares (new money is deposited) or redeems shares (money is withdrawn). A closed-end fund trades on an exchange, with a bid and ask like any other shares. The NAV may be greater or less than the market price of the fund at the end of each day.
Mutual funds Advantages
Professional money managers watch your money. They have more time and resources than most individuals who try to manage their own investments. Offers excellent diversification. Can benefit from up moves in a basket of stocks, and protects investors from company risk associated with investing in individual stocks. The safest way to invest overseas, because funds have managers watching international companies on which individual investors would find it difficult to gather information.
Portfolio managers
Portfolio managers, individual investors, and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging is not as simple as paying an insurance company a fee every year for coverage. Hedging against investment risk means strategically using financial instruments or market strategies to offset the risk of any adverse price movements. Put another way, investors hedge one investment by making a trade in another.